The Low-down on the 401(k) and the IRA

June 30, 2016

There are many different ways to save for retirement and a whole host of things to consider when tax planning. To reach your personal financial goals, it’s important to consider the resources available to you and review all of your options. The plan for you may not be the same for someone else.

The 401(k)

A 401(k) plan, as well as a 403(b) and 457, is a qualified employer-sponsored retirement plan. Not only do these plans provide for an opportunity to save for your future, but they can also reduce your taxable income today. Plus, you can save for retirement by making your contributions automatic and enjoy tax-deferred growth on your investments.

Here’s how it works: Enroll in your company’s 401(k) plan and contribute a percentage of your paycheck. At the end of the year, you can deduct your contributions from your gross pay, and therefore, reduce the chunk of money that you are taxed on. If you consistently owe taxes each year, contributing to your 401(k) plan may help you. Just as important, you are saving for your retirement.

Some of you may receive a company “match,” often times referred to as “free money.” A match is what your employer will contribute to your 401(k). It is in addition to your salary or hourly wage. Typically, but not always, you will need to contribute some percentage of your annual pay in order to receive the free money from your employer.

You are allowed to contribute up to $18,000 in a 401(k), 403(b) or 457 plan in 2016. For employees 50 or older, another $6,000 is permitted.

The IRA

If your company does not offer a 401(k) plan, consider opening an IRA (Individual Retirement Account).

Here’s why: Similar to a 401(k), a Traditional IRA is tax-deferred growth for your future. Additionally, an IRA may reduce your taxable income, similar to 401(k) contributions. This will depend on your adjusted gross income. If it’s under a certain threshold (varies if you are single or married), you may be able to deduct some or all of your contribution. It will depend, but it’s worth checking out.

Taking this a step further, a Roth IRA also allows for tax-free growth. The difference is that contributions to a Roth IRA cannot be deducted. However, withdrawals are tax-free provided certain conditions are met.

The contribution limit for an IRA is $5,500. For those 50 or older, a catch-up contribution of an additional $1,000 is allowed.